What is a Due-on-sale Clause and Why Does it Matter to Investors?

Many investors have asked me a variety of questions concerning a
clause that is common in mortgages and promissory notes called a “due-on-sale
clause”. A due-on-sale clause is a clause in a mortgage and/or promissory note
that provides that a default may be declared and the loan may be called due
(repaid in full) upon sale or transfer of ownership of the property secured by
the mortgage without the bank’s consent. In other words, the bank has the right
to demand full payment of the note if the property is transferred without the
bank’s permission (this does not include a traditional closing where the bank
is paid off and the lien released at closing).

…you may need to transfer your investments… into a limited liability company (or companies).

Edward Schenkel

Why should a real estate investor understand be aware of the
due-on-sale clause in a mortgage? For several reasons. First, as an investor,
you will want to make sure you are protected by keeping the property in a
limited liability company so you are shielded individually if there is a
lawsuit. This means that you may need to transfer your investments, which are
currently held in your name, into a limited liability company (or companies).
If there is a due-on-sale clause, such transfer may technically violate the
clause. Accordingly, you should be aware that if you transfer the properties in
a company without the bank’s consent, there is a risk the bank could declare
that this is an act of default and call the loan. However, this is low risk
since the bank’s primary concern is receiving the monthly mortgage payment and
that the property is not wasting away. Also, if the bank did complain, you
could transfer it back. Still, to be safe, it is recommended you either
purchase the property in a corporate entity or that you obtain the bank’s
consent before transferring the property to your company, even if it is a sole
member limited liability company where you are the sole member.

This means that you will have more bargaining power to discuss the terms you want in and out of the loan documents.

Edward Schenkel

Second, a good reason to understand the due-on-sale clause is so
you can negotiate it out of future deals, or at least negotiate room to transfer
to companies where you own an interest. As an investor progresses in his or her
career, he or she may find a good deal that involves seller or alternative
financing. This means that you will have more bargaining power to discuss the
terms you want in and out of the loan documents. Being aware of this clause
means that you can either take it out, allowing you to freely transfer the
Property to your companies or partners, or draft a due-on-sale provision that
is more flexible and suitable to your needs.